Dated data, poor policy

Financial Express, 21 April 2009

Will the RBI announce a cut in interest rates in its credit policy announcement or will this policy also be a non-event as have been the previous two policy announcements? A large number of market participants expect that no significant monetary easing will be announced. However, their expectations are based on looking at year on year price data which says more about the past and less about recent behaviour of prices.

For a long time the RBI appeared to have focused on the Wholesale Price Index. Now the WPI has come down sharply, and is close to zero, and a case could have been made to ease monetary policy. But more recently the focus appears to have shifted to the Consumer Price Index (CPI). Many analysts seem to be arguing that the RBI may not ease policy since the CPI is still high.

The CPI for Industrial Workers (CPI-IW) has been in double digit levels despite the decline in the WPI after September 2008. The question then is what is this attributible to and what does the RBI expect for the CPI in coming months. The latest CPI-IW data is available for February and shows inflation of 9.63 percent over February last year. Part of the reason for the increase in CPI is the larger share of food than is present in WPI. In CPI-IW the share of food is 46.20, in WPI the share of food is 15.4 percent. Food prices were rising at levels higher than most other components of WPI contributing to the rise in CPI-IW. In February, for example, the year on year rise in food prices was 9.8 percent and that in CPI-IW was 9.3 percent. All other prices grew more slowly. The only really unknown variable is housing prices, which has a weight of 15.27 in CPI-IW and for which no data series is available.

What might be expected for March CPI-IW? In March food prices have come down to a yoy growth rate of 6.9 percent. Considering that all other prices have come down even more sharply (WPI Manufacturing to 1.87, WPI fuel to -6.2, and WPI Primary to 4.07), it is likely that CPI will also hover at around 7 percent or below.

Output, measured by IIP, has in the meanwhile been falling sharply. The yoy growth figures are showing a decline sharper and more persistent than one has seen for more than 15 years. December showed IIP growth at -0.63, January showed 0.4 yoy growth and the February numbers were down at -1.23 percent.

The difficulty with looking at yoy data, rather than seasonally adjusted month on month data, as do all other central banks, is that instead of looking at recent trends, policy decisions are made by looking at the impact of shocks that have happened over the past 12 months. To use the latest trends to forecast the future, it is important to seasonally adjust the data and then look at month on month changes. Work at the National Institute of Public Finance and Policy ( shows how this has made a very big difference to the formulation of monetary policy in the past. Similar analysis is now showing a sharp decline in WPI inflation, far steeper than what is observed in the yoy data. For the period since September seasonally adjusted WPI month on month annualised inflation has been negative in 6 out of 7 months. In other words, after taking care of seasonal factors, month after month prices have actually been falling in most months.

Similarly when we look at seasonally adjusted month on month CPI based inflation the picture is more sanguine. While the CPI is not in negative territory, since October 2008 it has been in single digits in 4 out of the 5 months for which data is available. In February the annualised month on month seasonally adjusted number fell to 6.3 percent.

Central banks using seasonally adjusted data as described above, often prepare forecasts for inflation and output in coming months. These are not necessarily forecasts meant to be accurate to the point, but rather to describe scenarios which might play out in coming months. These scenarios are then used to convey to markets what might be the inflation and output projections that the central bank is looking at to make informed decisions about the future. Such analysis also helps markets to understand the logic of the central bank's policy decisions.

Indian markets would benefit greatly if the RBI could do similar analysis. One reason for not doing it is that inflation numbers are bad. The second reason could be that producing seaonally adjusted numbers is the responsibility of the Central Statistical Office, not the RBI. While all these are valid reasons, as our work above has shown, even a small effort by the RBI can go a long way.

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